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Investment Trends

Lower prices, higher yields make municipal bonds worth a look

Each time the municipal bond market starts to pick up, it gets knocked down again. The result, says one Milwaukee investment manager, is lower prices and higher yields that make for some tempting opportunities.

In May and June, when the Federal Reserve Bank began talking about raising interest rates, panicked investors abandoned muni bonds and other fixed-income securities.

"People convinced themselves they were going to have negative 20% returns in bond funds," said Brian Andrew, chief investment officer at Cleary Gull Inc. in Milwaukee. "That was the first kick in the pants for the muni market."

Muni bonds started to recover until the city of Detroit filed for bankruptcy in July. The largest municipal bankruptcy in U.S. history involved some $18 billion of debt. Money again flowed out of muni bonds.

In October, Puerto Rico's problems made their way to the front page, rattling muni investors further. The U.S. territory, whose bonds are exempt from federal and Wisconsin taxes, has more than $70 billion of debt, a shrinking economy, an aging population and a large, unfunded pension obligation.

The combination of all these factors has increased muni bond yields to the point where they are "really attractive" compared with corporate or Treasury bonds, Andrew said.

"We finished the year with muni bond yields at a place where we haven't seen them in a really long time relative to taxable securities like Treasuries or corporates," Andrew said.

The higher one's tax bracket, the more attractive munis are. Say a BAA-rated, 10-year muni bond — BAA is the lowest investment grade rating — has a 3.84% yield. Because muni bonds are exempt from federal taxes, an investor in the 40% tax bracket would be getting a tax-equivalent yield of 6.4%, Andrew said. But even an investor in the 25% tax bracket would get a tax-equivalent 5.7% yield, he added.

"In any environment, any time you can get a yield near 6%, that sounds to me like a pretty good deal," Andrew said.

Muni bond prices have risen an average of about 2% this year, but Andrew said he still believes they offer opportunities.

Andrew and his colleagues buy individual munis and muni bond funds for clients. Part of their strategy is to seek high income now that they can reinvest later at higher yields if interest rates continue to rise, he said.

Individual bonds may not be available from all brokers, and investors who buy them should have well-diversified portfolios containing many bonds, Andrew said.

Wisconsin-based investors who buy individual bonds will increase their yield by purchasing bonds of state-based municipalities for their double tax-exempt features, he said.

Glendale Community Development Authority Bond is due in September 2022 and is yielding 3.02%.

For investors in the 25% bracket, that's a tax-equivalent yield of 4% — about 1.5 percentage points better than the yield on a 10-year Treasury bond of 2.6%, he added.

Miller Park Sales Tax Development Bonds are due in December 2026 and are yielding 3.68%, Andrew said. For investors in the 25% tax bracket, that's a tax-equivalent yield of 4.91%, he added.

"We're all pretty confident that, despite the Brewers' troubles last year, they're still playing baseball there and putting a lot of people in the stands," Andrew said.

Goldman Sachs High Yield Muni IR (GYIRX, $8.93) invests at least 80% of assets in municipal securities. Although it is by name a high-yield fund, Goldman Sachs High Yield has 65% of its assets in investment-grade securities, Andrew said.

"You have to pay attention to how much Puerto Rican exposure these funds have, but this fund doesn't have a lot," he said. The fund has a 52-week trading range of $8.38 to $9.67.

As long as the Fed continues to buy bonds in the open market, muni bonds will continue to be attractive investments compared with taxable bonds, Andrew said.

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The Journal Sentinel focuses on one Wisconsin money manager or analyst in this weekly feature, looking at a trend that helps investment pros make their decisions.